Thursday, May 31, 2007

Why China's Growth Is Not Sustainable

There is a quasi-religious belief in some circles that China's current boom will last for decades. For those who seek facts rather than faith, consider the following excerpts from National Geographic's current article China's Instant Cities: (emphasis added)

"From 2000 to 2005, Lishui's population went from 160,000 to 250,000, and the local government invested 8.8 billion dollars in infrastructure for the region it administers. During those five years, infrastructure investment was five times the amount spent in the previous half century. In money terms, what was once 50 days' work is now done in one.

For the past three decades, China's economy has averaged nearly 10 percent annual growth. The economy is fueled by the largest migration the world has ever seen: An estimated 140 million rural Chinese have already left their homes, and another 45 million are expected to join the urban workforce in the next five years.

Such cities must expand and attract industry on their own, because the central government no longer provides the funding and guidance of the old planned economy.

Chinese cities aren't allowed to raise funds through municipal bonds or sharp tax increases, so they turn to real estate. Legally, all land belongs to the nation, but local governments can approve the sale of land-use rights—the closest thing to private ownership. Cities acquire suburban land from peasants at artificially low set rates, approve it for development, and sell for a profit on the open market. Across China, an estimated 40 to 60 percent of local government revenue is acquired in this way.

Formerly, the 16.5 acres (6.7 hectares) had belonged to the village of Xiahe, but in 2000 the city government bought the land-use rights for one million dollars. Three years later, Lishui flipped the land to Yintai Real Estate for 37 million dollars. Given that corruption is endemic in Chinese real estate, the actual price may have been even higher.

In such an environment, everybody gambles on growth. Most of the city's massive investment in infrastructure had been borrowed from state-owned banks, which also loaned money to the developers—Yintai had borrowed over 28 million dollars for its Jiangbin venture. If the real estate market went cold, the whole system was in trouble. During the past five years, the average price of a Lishui apartment had risen sixfold."

Allow me to summarize: local governments must rip off peasants and fuel a speculative real estate bubble in order to fill their coffers. They currently have no other choice.

This is the very epitome of unsustainability: a fiscal policy guaranteed to spark social outrage and guaranteed to bring on a speculative bubble's collapse.

If it is now your religion that China's boom will extend for decades, then your faith is resting on some very tenuous threads of reality.

What happens when there's no more peasant villages to steal and flip for a 50-fold profit? Then how will local governments collect revenue for their payrolls and infrastructure?

What if local housing stops rising six-fold and actually declines due to overbuilding or the deflation of the global real estate bubble (i.e. "hot money" flowing in from outside or from government banks)?

What if farmers/peasants begin to actively resist the theft of their land? This is apparently already the case in many locales.

These are just a few of many such pressing questions regarding the sustainability of the system.

"Concerned about a slowdown of contracted foreign investment, the Shanghai municipal government has eased restrictions to lure foreigners to invest in property development again, in a reversal of an earlier policy aimed at cooling down the real-estate sector.

"Shanghai's property market also showed signs of cooling down in January-April, although housing prices in all other major Chinese cities continued to grow significantly. The average property price in Shanghai fell 3% in the first quarter, compared with a 9% increase in the same period last year."

Albert summarizes the situation thusly:

"This is an interesting development. I smell a bubble bursting, and they need the final sucker to bail out the speculators (everyone). "

When everyone is a speculator playing with borrowed money, it's a mania/bubble, regardless of the nation or the era--and all mania/bubbles end the same way. If you need further evidence that the bubble in the Shanghai stock market is a mirror of the bubble in Shanghai real estate, consider this tidbit from Shanghai slump as China cools markets:

"An indicator of the widespread speculation gripping the Shanghai exchange came last month with a Chinese government website reporting that one in 10 maids in the city, China's financial capital, had quit their jobs to take up trading full time."

When maids are quitting to play the stock market and local governments are relying on flipping stolen land to speculators, the mania/bubble is clearly about to burst. Maybe afterward, when people have lost their fortunes and their anger knows no bounds, then a more sustainable model of development will arise.

Wednesday, May 30, 2007

Why Interest Rates Will Have to Rise

This may be one of the most important entries of the year. I admit, it's not truly earth-shattering like the news of which airhead starlet has been arrested this week for a DUI on the Pacific Coast Highway, but since it's about money on a global scale, it might be of some interest (pun intended).

Let's go through the standard reasoning about interest rates. One school of thought believes that the bursting of the global debt bubble will lead to deflation, and this will cause the Federal Reserve to lower interest rates in order to keep the bubble (borrow and spend) economy pumped up.

The other school of thought foresees inflation or even hyper-inflation as the inevitable result of a hyper-inflationary monentary policy (easy lending, low rates, endless funds available for lending). To save what's left of the dollar, the Fed will eventually have to raise interest rates.

What if both scenarios are missing the point? What if interest rates will have to rise regardless of inflation or deflation or the slowing economy?

Let's start with a chart, courtesy of www.brillig.com (the debt clock). This is an inflation-adjusted depiction of the U.S. National Debt--the debt which has accumulated from years of massive deficit spending and borrowing from foreign entities. (The comments in black are mine.)

Do you notice the tiny little difference between the previous Bull Market era of prosperity (1946-1966) and the current era of "prosperity"? Hmm, this is a tough one. . . could it be those decades of massive, explosive deficits?

What kind of "prosperity" requires borrowing trillions of dollars to sustain it? Can it even be called "prosperity" if a significant driver was borrowed money?

Even during the "non-prosperous" Bear Market era of stagflation in the 70s, the nation didn't borrow much more than it had during boom times (adjusted for inflation, which rose in the late 70s and early 80s).

For a comparison of that era and our own, let's turn to correspondent Mark P.'s recent observations: (emphasis added)

"I was reading this article on rising gasoline prices and started to think about the past, particularly the late 70s when I was a kid.

This article is pointing out that gas prices are going to hurt consumers soon and cause the consumer to reduce consumption (this should be a world wide phenomenon in industrialized countries). This spending pullback may tip the economy into recession (considering that last year the economy was barely growing and 70% of the economy in consumer spending).

Remember in the late 70s we had some inflation, a little growth and then pow, a huge gas spike... That sent the economy into stagflation. I believe that we may be looking at that same scenario again. Remember how the government solved the stagflation of the early 80s??? Ronald Reagan spent about 1 trillion dollars (doubled the national debt at the time) to buy military equipment and Paul Volcker raised interest rates to insane levels.

The interest rates cause the value of the dollar to increase thus making foreign products cheaper. Producing more spending, combined with government spending righted the economy.

If the same scenario happens again the first question is: can the government make the same kind of impact? We have all seen that the Fed doesn't have anywhere near the same ability to control the interest rates as it once had almost 30 years ago. We also know that it is taking more and more spending to generate each dollar of economic growth.

In the current situation the interest rate change will make the dollar rise and make foreign products cheaper. Remember house values and interest are inversely proportional. So high interest rates could implode the housing bubble.

But a side effect of high interest rates could be a huge impact to all of the people with adjustable rate mortgages. Would people whose home values are plummeting or that are losing their houses (because that can't be sold for what they are worth) be willing to spend more for stuff (the people that lost their homes would have no place to store the stuff)??? Any interest rate increase would impact the already leaking housing bubble. I can't believe that the politicians could even fathom this option.

If the government tried to spend their way out of a stagflation scenario they would have to borrow MASSIVE amounts of money (possibly double the national debt). Currently, there is enormous downward pressure on the dollar due to all of the debt being created by the US goverment (due to the borrow and spend Republicans). The dollar has suffered about a 25% decline against the Euro since early 2001 ( Federal Reserve website). The dollar has fallen against most unpegged worldwide currencies ( Federal Reserve).

So, what would massive federal spending do?? First it would cause massive federal borrowing, causing the dollar to fall if not collapse. Since most of the goods we buy come from foreign countries debt creation would in turn cause inflation, which would make an inflationary situation worse and reduce economic growth.

Unfortunately, the government looks like they would have limited solutions in this scenario. I think they would try the easy way out first, just making the problem worse. "

Mark's commentary led me to this conclusion: the debt is already so large, the Treasury will soon have no choice but to raise long-term interest rates. To see why, let's look at another chart:

Notice how the Chinese central bank has ramped up its purchase of U.S. Treasuries to what is clearly an unsustainable rate.

Before we go on, let's recall a few key points:

Interest rates are not set by the Fed--they're set by the bond market and the Treasury Department, whose job it is to sell the Treasury bonds. If there are no buyers at 4.5%, they must raise rates until buyers appear.

It's not just new bonds (i.e. new deficit spending) which must be sold--hundreds of billions of old debt rolls over and must be re-sold. Those 6-month, 2-year, and 5-year Treasuries come due and must be rolled over to new buyers. Recall the Treasury got rid of the long bond (30-year bond) for a number of years, meaning all debt sold in those years is short or medium term.

Foreign entities are major buyers and owners of Treasury debt. Simply put: if foreign buyers decided to diversify their holdings and/or stop buying U.S. bonds en masse, there is no evidence that U.S. investors would or even could absorb those trillions in Treasuries.

There is no guarantee that the world will be able or willing to fund our current debt, never mind the next $5-10 trillion we might want to borrow. We have been lulled by the stupifyingly lopsided buying of the Chinese central bank into thinking that no matter how much we borrow via deficit spending, some kindly soul will pony up a trillion in cash to buy our new debt.

If there's no longer buyers of Treasuries at 5%, then the rate will rise to 6%. If there aren't enough buyers at 6%, then the rates rises to 7%, and so on. That's how you get 10% interest rates-- which were once the norm.

The cliche repeated in the mainstream media is that China continues buying hundreds of billions of U.S. bonds every year as a "safe" investment." How "safe" is an investment which has lost 1/3 of its value in the past 5 years? (The dollar Index has fallen from 120 in 2002 to 82.) We all know the real reason China has been pouring the vast majority of its foreign reserves into Treasuries--to support low interest rates and therefore the purchasing power of the dauntless "borrow and spend" American consumer.

The larger question is: how sustainable is a debt machine dependent on the fortunes and good will of one's trading partners?

What could cause the Chinese to cease new purchases or to even start selling Treasuries from their horde of $1.3 trillion? (It's rising by about $125 billion a quarter.)

A U.S. Congress-mandated trade war might induce the Chinese to stop playing patsy to the U.S. Treasury. Many observers are claiming a veto-proof tariff bill is now a near certainty.

The Shanghai Composite stock market collapsing (now a mere matter of days or weeks away) could trigger a massive government spending spree to quiet the social unrest caused by tens of millions of neophyte investors being wiped out. How to raise a needed $100 billion or so? Sell Treasuries, and stop buying them.

A U.S.-led consumer recession will take a huge bite out of China's surplus, reducing their ability to purchase more Treasuries. (Recall that their global surplus is far less than the surplus they run with the U.S.)

The dollar's steady erosion is already forcing the Chinese to diversify their holdings; their appetite for another 30% loss of value is declining rapidly. With a $1.3 trillion stake in the dollar, another 30% decline will shave off $400 billion in value from their holdings. This is not a trivial loss, even to the Chinese government. There are already voices there saying that the governemnt should invest those hundreds of billions in China rather than gamble them all in the market for U.S. Treasuries. And who could disagree?

Once the Chinese either decide to stop supporting the U.S. debt machine, or find they no longer can do so regardless of their desire, the market for low-interest rate Treasuries dries up. Yes, the Gulf states are big buyers, too, but there is no evidence they can double or triple their bond purchases to cover what China currently buys.

How vulnerable are we? Very. One solution is to stop running deficits of $300 - $400 billion a year; that would be $400 billion less debt we need to find buyers for. But which of our elected officials would have to courage to cut $400 billion in spending?

The real problem is the debt is already unsustainably large. Even if we as a nation stopped spending more than the government collects, the existing debt constantly rolls over and has to be refinanced. If money dries up globally, we are in a real pickle. With a negative savings rate, does anyone seriously believe we can fund our own deficit?

And here's one more "follow the money" line of thought. Who gets hurt if the Treasury refuses to support the plummeting bond/dollar by raising interest rates? Joe Sixpack? Not really.

How much does Joe Sixpack buy that is made in Europe or Japan? The Japanese nameplate vehicle he buys is actually made in the U.S.; only the profit is repatriated to the home country. If he travels outside the U.S., then the weak dollar will hurt his purchasing power--but how often does Joe Sixpack go to Europe or Japan? (Recall that the Chinese yuan is pegged to the dollar and does not fluctuate much even as the dollar tanks.)

As for food--it's mostly priced in dollars. Ditto oil/energy, so a plummeting dollar will have little effect on Joe's purchase of these commodities (unless OPEC starts pricing oil in euros. Then it's Katie Bar the Door.)

No, the big losers in a bond/dollar collapse are the wealthy. As documented here many times (via links to the Wall Street Journal), the top 5% of U.S. citizens own about 2/3 of all the stocks, bonds and real estate in the country. If the bond and/or dollar drops through the floor, their holdings will be worth a lot less globally--and the wealthy of the world are global players.

So ask yourself: if our patsy trading partners are no longer willing or able to gamble all their surpluses on the dollar and Treasuries, or we have finally worn out our welcome in China and the Gulf so that politicians/bankers in those regions decide to stop supporting low interest rates in the U.S., then will our politicians really care about Joe Sixpack losing his bubble-priced home?

The short answer is no. They will care about the wealthy, who fund their campaigns. Joe Sixpack doesn't even bother to vote (U.S. voter turnout is barely 40%; in the recent French election, turnout was 85%.) Yes, there will be tearful speeches and a lot of hot air expended about poor Joe, but when push comes to shove, the Treasuries have to be sold--there is no Plan B--and the wealthy's holdings in dollars will have to be defended.

Joe Sixpack? Sorry pal, suck it up; you blew it signing that adjustable rate mortgage and paying bubblicious prices and tapping all your equity with a home equity line of credit. Too bad you believed all that mainstream media shuck and jive about interest rates staying low forever.

Thank you Abrey M. ($25.00) for your generous and quite unexpected donation. I am greatly honored by your support. All contributors are listed below in acknowledgement of my gratitude.

Tuesday, May 29, 2007

What to do about Health Care?

Here is the one essay you need to read this year about healthcare in the U.S. It will change your perspective, for it offers contexts and solutions I've read nowhere else. I asked frequent contributor Michael Goodfellow to write down the many healthcare-related ideas we've shared via email, and he's written this perceptive, thought-provoking essay: What to do about Health Care? Here is the first paragraph:

"Charles asked me to write something about the health care system in the U.S., but before I do that, I should add a few words about my own situation. The opinions below could be read as a rant by some overpaid techie who has never been sick a day in his life. Sadly, that is not the case. I sustained a spinal chord injury at age 7, and have spent the rest of my life in a wheelchair. Long-term paralysis leads to other complications, and so I now have multiple serious conditions. I have seen more than my share of the health care system."

For another "real world" window on our healthcare system, please read yesterday's entry, "The Test of a Nation." After pondering this critically important issue, you might enjoy an amusing serving of witty parody, Memo to the next UK Prime Minister by Protagoras.

Monday, May 28, 2007

The Test of a Nation

A Memorial Day thought: The test of a nation's commitment to its Armed Forces veterans is two-fold: how they are treated during a war, and how they are treated five, ten and twenty years later. With some 60% of Iraq War veterans experiencing some form of PTSD (post-traumatic stress disorder), I have to wonder if we as a nation will abandon the vets as soon as the war winds down, as occured after Vietnam.

I hired many Vietnam vets when I was a builder in the early 1980s, not because they were vets (I didn't ask) but because they were looking for work. A number had psychological problems relating to their service in Vietnam; these problems included extreme withdrawal, outbursts of rage, and inability to concentrate. Others were drifting through their 30s, camping at the beach, while one set of brothers took their Mom with them wherever they found work. I rented a camper on the jobsite for their Mom and paid her a small sum to keep an eye on things. (She was one tough cookie; by her own choice she was armed, as she knew how to handle firearms.)

Would the guys have been troubled even if they hadn't served "a one-year hike through the jungle" (one's apt description of his 'Nam duty as an infantryman)? Perhaps. Would the Veterans Administration facility on Oahu (Honolulu) provided sustained treatment for them? Perhaps. Did they even consider going in for treatment? Perhaps not.

What I do know is that we as a nation shunned these vets, underfunded the VA system, and generally ignored PTSD or "blamed the victim" (aw, those guys are just whiners, etc.). I fear that once hostilities in Iraq wind down (for whatever reasons), the nation will quickly avert its eyes from the individuals who paid the price internally for their service and rush to cut the VA (and military readiness) budgets as the recession bites deeply into tax revenues.

I hope we won't repeat the tragic cycle of postwar denial and abandonment suffered by many Vietnam-era vets, but I am not confident that our nation will choose to spend money to support our vets long after the war is over. I fear the powerful constituencies protecting entitlements (Medicare, etc.) and pork projects will raid the VA budget to protect their own turf. For you see, vets are not politically powerful; those who are suffering often do so privately. And you can be sure the puffed-up pundits who have glorified the war will be the first to forget the vets who actually served.

Continuing on the theme of responsibility: Knowledgeable correspondent Nurse Dorothy offers an "in the trenches" reaction to the May 24 entry on health and healthcare. I believe her comments are extremely important, and speak to issues which are virtually ignored in the mainstream media and the halls of Congress. Here is the chart she refers to:

"This is in regards to March 24th Health and Bankruptcy article. I know it's a little late in responding, but I just came off of a four day stretch at work. In that article there is a purple circle which says "I want a pill, blame someone else for my ill health". That statement screamed at me because it's so true. I have the perfect example.

This weekend I took care of a 60 year old, overweight women who has an active bleed in her colon. She has been with us for three weeks. She has refused a colonscopy among a few other treatments and tests which are needed to treat this condition. She has also continuously violated our no smoking policy as well as her diabetic diet with the help of her family. You may ask why not just send her home then. We can't because if we do and she dies at home, we will surely be sued as her family has already threatened it. The patient and the family are in no hurry to get her home even though she has no insurance. Why because Medicare pays for part of it and the rest goes unpaid by the family.

Even though we have plenty of documentation of her un-cooperative behavior in everything, we will still be sued and the family will more than likely win the case because our country is adverse to personal responsibility. Although this case is an extreme one, I would say half our patients are not willing to do what is necessary to get themselves back in better health and we as citizens pay for that.

Anyway, I thought I'd share this example with you mainly because I just needed to vent my frustration at our citizen's lack of discipline and responsibilty for their own health care. "

Thank you, Nurse Dorothy, for "plain speaking" to an issue we as a nation refuse to address: personal responsibility. Those of us who know working physicians and/or administrators in the "healthcare delivery systems" (i.e. hospitals and providers) know the medical malpractise system is utterly broken. Yet at the same time, I wonder if a class-action lawsuit might not be the only weapon vets will have to channel funding to the VA when its budget is slashed to protect more politically powerful government-funded fiefdoms.

Responsibility is two-fold: as a nation, we are responsible for the care of those who served, especially those who served in combat. We must keep in mind two things: service is voluntary, and the orders to go to war come from our civilian, elected government, not the Pentagon or senior military officers. Therefore we as a people sent them to war, and we are duty-bound to take care of them, regardless of the war's outcome.

As individuals, we are responsible for our own health. It will come down to this, readers: we can either fund our VA hospital system, or we can pay for irresponsible civilians like Nurse Dorothy's trigger-finger-on-a-lawsuit patient. There won't be enough money for both, and we as a nation will have to choose who gets our support. My vote will always be for full VA funding, above all else--even my own Medicare benefits, should there be any left when I qualify.

Today, and every day, my thoughts are of our friends who are serving in Iraq. Words fail me; just look at this photo.

Saturday, May 26, 2007

Memorial Weekend Amazing Offer In keeping with this weekend's great theme--no, not sacrifice for the nation and liberty--you know it's "two days only! Blow-out savings!" marketing and sales-- I am offering an incredible value here relating to a numerologically significant event.

In an astonishing show of support, 99 of you stalwart generous readers have donated money to this site in the past two months. Others have sent me boxes of their favorite peanut butter (after I noted the difficulty in finding an honest peanut butter unadulterated with hydrogenated palm oil or high-fructose sugar), a music CD by a favorite local musician, and a beautiful handcrafted wind chime designed to celebrate the U.S. Constitution.

In the spirit of blatantly cheesy marketing which dominates this weekend, I am offering the 100th person who donates cash to the site a free collector's copy of my novel I-State Lines, which is suitable for holding down paper on your desk or propping up a wobbly table. Please note that the book costs me $10 from my publisher (yes, surprisingly, a highly honored small publisher of literary fiction, The Permanent Press of New York) and $2.13 media mail shipping.

If you read fiction, you'll enjoy browsing their current and past offerings on their website; you'll probably find something which fits your tastes in their selections, which often win literary prizes. Recently published works include the true story of a Boston Madam (yes, that kind of Madam), several family dramas, a Cold War story and a mystery set on Long Island.

The actual value of my book may vary, depending on your acceleration and tire pressure; when viewed in a mirror, it may appear larger than in real life. Fluctuations in polarity may result during reading. Side effects include drowsiness; do not operate large complex machinery while reading. It's kind of cool to have a book personally inscribed by the author on your shelf; at least as a reader, I think so. For it creates an authentic connection between a mass-produced object (the book), the person who made it (the author) and the reader/owner.

Those kinds of connections are rare in a "consumer society" where the value of an object is generally reduced to its price, utility and/or brand status. No wonder so many people feel dissatisfied and alienated; the more they shop, the more they buy, the more they own, the less they actually get. The objects they buy/own are simply grist for an empty cycle of buying, storing and then selling/giving away/disposing in the local landfill.

There's not much connection left between the people who make objects of not-entirely visible value and the people who value them.

If you're sick to death of marketing and hype but can't resist this fantastic, one-of-a-kind offer for the 100th reader who wildly abandons reason and sends in a donation, then

Friday, May 25, 2007

Waste and the Federal government are basically synonymous. The list is basically endless, but just to hit the highlights:

The profiteering war in Iraq. Thanks to longtime correspondent U. Doran, we can learn that our soldiers have been ordered to have KBR (formerly Kellogg Brown and Root, Lyndon Johnson's old Texas buddies who made millions building all those bases in South Vietnam we left for the incoming Soviets) do their laundry for $100 a bag: Iraq for Sale.

Highways and bridges to nowhere. (boondoggles and pork to highway and construction industries)

Pentagon waste and fraud. (multiple levels)

Interest on National Debt. $240 billion paid each year (and rising fast) mostly to foreign entities who have kindly financed our trillion-dollar borrowing binge. If that isn't criminal waste, then what is?

The above chart shows where all this is heading: national bankruptcy. Expenses (entitlements, Homeland Security, Defense, interest on debt) are rising far faster than income (tax payments) and will soon skyrocket beyond any hope of borrowing to fill the gap.

In other words, blah blah blah. Nobody cares--yet.

So let's turn our attention to local government, which is also teetering on insolvency nearly everywhere even at this peak of "prosperity." By local government I mean not just cities, counties and states but also school districts, municipal water systems, university systems, housing authorities and the vast array of other governmental bodies which live wholly or partially off tax receipts.

For an aperitif, let's take a quick look at a few examples of the waste, fraud, "gaming the system" and insanely optimistic financial projections which are built into local government.

"The Berkeley Housing Authority has paid rent on at least 15 units where tenants are dead—as much as two years of rent on the deceased, failed to inspect units where substandard conditions exist, and allowed ineligible family members to “inherit” a unit ahead of others on the waiting list.

These are just a few of more than a dozen serious problems cited by City Attorney Manuela Albuquerque in a report to the Berkeley Housing Authority members. The report also recommends the removal of all housing authority staff except new manager Tia Ingram.

HUD (the Federal Housing and Urban Development department) has deemed the Berkeley agency “troubled” since 2002; if the authority does not significantly improve, it could ask an agency outside Berkeley to manage the city’s low-income housing efforts.

The housing authority “has long been the Siberia of Berkeley’s ‘no lay-off’ policy,” he said.

Employees won’t be laid off. “We’re looking at it as a major reshuffling,” City Manager Phil Kamlarz said in an interview Monday. Some employees may go through the city’s “progressive discipline” procedure in other departments, he said. "

Allow me to summarize: A city agency has been "troubled" i.e. incompetent, fraud-ridden, etc. for five long years before the city finally takes action. Then the employees and managers are rewarded for their fraud and incompetency with lifetime employment and rich lifetime benefits.

Predictably, the public employee union is already threatening action against the city.

"Service Employees International Union 1021 officials said Wednesday they are seeking legal advice regarding the council action, as it may have violated workers’ contracts."

In other words: there is simply no level of fraud or incompetency which public employee unions will not defend to the bitter end.

Frequent contributor Albert T. sent in this story about a 65,000-employee public pension plan which is finally facing the realities of slower stock and bond market returns. The stupendous under-funding of public pensions is a little-noticed iceberg we as a nation are about to hit.

"Nationwide, the New York Times reported, "state and local governments owe their current and future retirees roughly $375 billion more than they have committed to their pension funds" by one estimate; that number balloons to $800 billion, it wrote, "if America's state pension plans were required to use the same methods as corporations." Public-employee pension funds are not covered by federal pension law, held to a uniform accounting standard, or protected by the PBGC; instead they're governed by boards with relatively little oversight, and must appeal to the taxpayers to fill the gap if they end up in the red.

"UC Regents' plan to restart contributions to the UC Retirement Plan (UCRP) in July 2007, following a 16-year "holiday" during which UC and its employees did not pay into the pension fund.Allow me to summarize the situation nationwide: The outsized gains in the stock and bond markets in the 90s infused managers of public pension funds with the irrational exuberance that such returns were now "normal" and could be counted on indefinitely. Therefore, most pension plans inserted wildly improbable annual returns in their projections."

Alas, 16% annual returns turned out not to be normal but a brief aberration. In those heady days, so great were the returns that public employees didn't even have to contribute a dime to their own pension plans. Now they are up in arms because they actually have to contribute a small (1%-2%) amount of their salaries to their own pension plans.

The debate now rages between those who want the pension fund to be "actively managed," which generates hundreds of millions in fees for outside financial management firms, or "passively invested" in index funds.

Albert made this point about "actively managed" funds:

"Actually funny a little since we are on the topic there was an article review I did for one of my classes on an article from journal of finance about fund management. Basically 80% of funds fail to cover their fees and perform worse than the benchmark they pick. Only 10% of funds cover their fees with returns in excess of the benchmark. There was one funny thing in that paper: basically about 120+ funds did -5% per year or less but by luck alone only 60+ funds should have... So the others are there due to "skill".

What nobody in the public pension world seems to address is the possibility--or even the extreme likelihood--that annual returns on their funds could be a negative number fot years to come. Everyone seems to have forgotten that stocks and bonds can actually drop in value for years. What happens when the fund drops 16% per year for a few years, rather than grows by 16%?

"Despite a stock market setting “new highs” even states are struggling to make ends meet. What happens as property values continue to collapse forcing a downward readjustment of property taxes causing a drop in tax receipts followed by a sharp increase in unemployment causing an even greater drop in tax receipts, followed by sharply decreasing corporate earnings due to fall off in consumption causing an even greater decrease in tax receipts."

Just how painful this cycle will be can be ascertained by looking at the phenomenal growth in property values (and thus property tax receipts) local governments have enjoyed. For example, Florida:

There is one more massive piece in the coming cycle of declining tax receipts: the destruction of small business. Correspondent Brian H. files this report, which all of us self-employed /small business proprietors can instantly relate to:

"It’s not just healthcare, it’s all the endless mind-numbing rules by our beloved nanny-state government.

You really just have to decide which ones to ignore. (which isn’t a good long term thing for any form of government)

Why do illegals own the lawn care business? Because they ignore most of the rules.

Let’s not forget workman’s compensation, all the OHSA rules, all the safety rules, all the EEOC rules about who you can hire, where you can dump grass, when you can operate machinery, how old you can be, etc, etc, etc. Let’s not forget break times, when to clock in and out, keeping records for yeas, etc. Building inspections (of both yours and the one you work on), bidding rules, bonding. Even the type of can you can put gasoline in is tightly regulated. After a while, it’s like, well, we’re doing it, but we’re not doing it.

How can I, a law abiding citizen, compete with that? My overhead is 3 times what theirs is. Back when I used to do lawn care (before giving up and finding something with better barriers to entry) I’ve bid jobs where their bid is less than my parts cost. How can that be?

Do you know why spraying your lawn for weeds costs so much?

It’s not the chemicals, or really the equipment, it’s all the GD rules. Here in Colorado (which is probably way less than NY or Kali or somewhere else), you have to get a license (and of course pay for it), which includes taking a test and passing it. Then, your supervisor also needs to pass a bigger and harder test and the yearly license costs about $300 This needs to be with you at all times, and the supervisor needs to be on duty when you are spraying. Then of course, you need business insurance. Which, sit down, for a one person truck, with all the licenses is about $8,000 dollars per year (yes, that’s right, eight grand, my plumber, a one person truck, pays about 1200 a year)

All of this just to spray 2,4D on your lawn which you and I can buy as private citizens in WalMart. (also known as Weed-B-gone).

No, we don’t spray, and we can’t even find someone to subcontract to do it. Who wants to? And if you do find someone, it’s expensive as hell, because of all this crap.

That’s just one example. Heck, just today my wife has to go register our trailers. (why exactly do I have to register cars anyway? They don’t drive, they don’t have privileges, they don’t go out on the street by themselves at night without supervision).

1. it’s going to be a couple hundred dollars

2. it’s going to take hours

And for what? Absolutely nothing, just another damn tax.

Get the damn government out of the way and we could do amazing things."

Every year we pay over $1,000 "city business license" for the stunning privilege of operating a legitimate business in this city. This is a percentage of gross income, not net, meaning if you are losing money, the city doesn't care: you pay them first out of gross income.

This kind of "junk fee" which returns absolutely no benefit, and which seems to rise by leaps and bounds every few years (the city just raised another small-business tax by about 30%) is rife in local government. And do you know the predictable result? Small businesses are closing, going out of business. If you don't think this is a reality, you need to get out more. And with the loss of those tax receipts, you also lose jobs.

The media loves to focus on big corporations, but the real engine of employment growth is small business. Once you strangle that sector with rules, fees and taxes, then you've strangled both your tax and employment base.

Astute observer/correspondent Riley T. sent in a report which nicely summarizes the two issues of unaffordable/underfunded public pensions and the wearing down of small businesses:

"I know this will sound crazy but I wonder if there really is something in the water. No one seems to care about what's going on. I can't find anyone I know personally that can even imagine that something could go wrong. A good friend has a navy pension, a California state pension and Social Security it is impossible to get him to even think that something might go wrong. I have a nephew who had saved up $6500 and he used every penny to buy a juke box.

I have driven around the country in my motor home during the summers and there are a huge number of businesses closed. Closed businesses are not included in the governments calculations.

I truly don't know any one personally who thinks there might be a problem. I agree with you that the stock market is on the verge of collapse. Housing is the same. What the hell is going on? Something has totally fried their brains."

So why don't we read more about these issues? We can only speculate, but the fact that the print media itself is largely unionized may have something to do with the limited coverage of public pension plans and local government fraud/waste/gaming the system. Since the reporters and editors are union members, their sympathies rather naturally reside with public employees, not with the small businesses which ultimately support the local government with direct taxes and the jobs which also generate taxes.

Now let me state yet again that many public employees I know are hard-working, conscientious people whose offices are chronically understaffed. The problem is that the system (agencies and their unions) enable or even encourage incompetent/lazy workers to "game the system" to milk maximum pension and retirement benefits. And what kind of work ethic and productivity do you engender when employees know they can never be fired, no matter how much they rip off the public they supposedly serve? To claim this is not a pervasive, deeply eroding problem is to simply be in denial.

So when will these issues gain attention? When local governments start declaring bankruptcy to get out from contracts that are no longer affordable, when pension plans fail, and when tax receipts plummet. But we're not there quite yet; perhaps 2008 will be the first year of reckoning.

Until then--The Truth Can't Be Told. Except perhaps on page B-27, every once in a while, without charts, graphs or splashy headlines, just a boring little sidebar no one notices.

Thank you Michael M. ($16.00) for your unexpected and generous donation. I am greatly honored by your continuing support. All contributors are listed below in acknowledgement of my gratitude.

Thursday, May 24, 2007

This Week's Theme: Why The Truth Can't Be Told

Health, Healthcare and Bankruptcy

If I were a small-business employer, I wouldn't hire myself. Why? I'm over 50. Maybe I'd hire myself for cash, more or less like a day laborer; but as an employee with healthcare and other benefits? Are you insane? The healthcare premiums are over $1,000 a month.

Would I hire a guy or gal with three kids? Heck no, same reason. Bennies cost too much. Would I hire a diabetic or person with chronic health conditions? No way. Would it make financial sense for me to hire a no-benefits contract worker, or a "non-legal" worker for cash? Absolutely.

Some readers have pointed out that employee healthcare costs are not an issue to global companies like Exxon, but the truth is large multinational corporations have been shedding jobs in the U.S. in favor of foreign-based workers for years. This is largely the result of global reach--it only make sense to grow your workforce where your markets are also growing--but I doubt Intel et. al. are entirely impervious to rising medical and pension costs in the U.S.

For a snapshot of an ailing U.S. company in an ailing industry, consider these "legacy costs" for auto maker Chrysler: In for an overhaul.

"Cerberus Capital Management, a New York private equity firm, will pay $7.8 billion for the iconic automaker, with almost all of that going to recapitalize Chrysler.

Nearly a decade ago, Daimler paid $36 billion to buy Chrysler. Now, the same company will pay $650 million to rid itself of Chrysler and its $18 billion in pension and health care obligations.

It will face pressure to make Chrysler more competitive. Chrysler, which lost $1.5 billion last year, estimates it pays $30 an hour more in labor costs than its Japanese counterparts. GM and Ford have similar disadvantages, which is simply untenable. "

That $30/hour isn't wages--the Japanese aren't paid $10/hour and the U.S. worker paid $40/hour. It's the "overhead" costs for medical insurance, pensions, vacation, sick-leave, etc. It's painfully obvious that the only way Chryler will survive is if the $18 billion in pension obligations and the ongoing billions to pay for generous healthcare and other benefits are slashed/eliminated.

The heading-for-bankruptcy "healthcare" system in the U.S. is the elephant in the room no one wants to talk about when it comes to "saving or creating jobs" in the U.S. Capitalism can be boiled down to this: capital will flow to the highest returns. Once the burdens of healthcare, sick leave, etc. become too onerous then capital will leave for higher-return climes and businesses.

So let's get real. The decision for global corporations isn't between jobs in the U.S. and China--it's between expanding the workforce in China or India, Vietnam, Poland, Brazil, etc.

It's also inaccurate to keep talking about cost, as if the problem with healthcare in the U.S. was simply money. It isn't. It's an entire system of ill-health:

I have discussed the packaged food industry's game of shuck-and-jive when it comes to labeling the food you're eating: "organic" peanut butter loaded with hydrogenated palm oil, the high-fructose sugar laden bottled beverage which contains "two servings" as a way of making the calorie count look reasonable, and on and on. Pet food is much more accurately labeled than human food.

I have also discussed how our built environment is not condusive to walking and biking--the easiest ways to get some exercise. The waste, fraud and poor results which result from a litigious, ill-informed, profit-driven society's attempts to "fix" poor health with pills and surgery is too well documented to be worthy of elucidation. Everybody knows this but no one wants to make the sacrifices/trade-offs necessary to get past these barriers.

So we're left arguing about how to pay for a broken system which is heading off a cliff of fiscal insolvency. Rather than talk about reality--that the broken, inefficient, ever-more-costly "healthcare" system is a key driver in why good jobs are disappearing in the U.S., we argue about details--the classic "rearranging the deck chairs on the Titanic"--as if a cost-based debate will solve poor diet, unhealthy food, sedentary, passive "consumer" media-centric lifestyles, greedy pharmaceutical companies, public hospitals hovering on the brink of financial disaster, and a host of other ills of our system too long to even list here.

So why can't we have an honest discussion of the many causes of this catastrophe? The answer is profit: the immensely profitable web of the food industry, the doctor-owned clinics, the drug companies, the paper-pushers who bilk Medicare, the public "healthcare" companies, etc. If the system were revolutionized to make health an incentive rather than the current system in which ill-health is "the profit center," then all the profitable apple carts would be overturned.

And that is Why The Truth Can't Be Told. Here's one more chart for your review:

Wednesday, May 23, 2007

One of the great pleasures of studying another culture in depth--its language, geography, history, literature, food and film--is the discovery of universal truths through a different lens.

With that flourish, I introduce the 1954 Japanese film Ugetsu which is on virtually every major film critics' list of the Best 100 Films of All Time.

One reason is the movie's haunting visuals (in glorious black and white); once you've seen the film a few times, you may be hard-pressed to pick your favorite sequence; mine is the two "heroes" deathly quiet voyage across the mist-bound lake.

But the deeper reason why this is such a compelling and unforgettable movie is its unerring depiction of the destructive force of human greed. Greed is a "standard-issue emotion, human being 1.0"--we all know the sensation of desiring wealth, power and prestige.

What's changed is that where greed was once a Mortal Sin, it is now an unalloyed Good Thing. Just for your review, here are the seven deadly/mortal/cardinal sins:

pridegreedenvyangerlustgluttonysloth

It doesn't take a theology student to note the over-arching theme of greed/unlimited desire for more than one's fair share in this list; what is pride but the desire to display the results of your greed? What is envy but thwarted greed? What is lust but sexual greed? What is gluttony but greed for food?

Just how greedy has our culture become? Item 1 for the prosecution: hedge fund managers are making up to $1 billion each (average is $360 million for the top 10):

It's instructive to consider the $1 billion some financial manipulator earned for producing no goods or services with someone who is worth a $1 billion as a result of creating goods and services which generate jobs, value and tangible wealth--say, Steve Jobs. Leaving aside his personality--by most accounts abrasive, abusive and volatile by turns--let's recall what created Mr. Jobs' great wealth: the desire to build something which was "insanely great." This he went on to do, with plenty of help from PARC, Mr. Wozniak and many others. Nonetheless, his zeal was not purely financial greed.

This used to be the Standard Issue American Dream: to create great wealth via hard work or innovation or some combination of the two. This vision quest has now been reduced to pure greed for wealth or status by any means.

Many observers find this "greed is good" ethos best represented by the Reagan-era film Wall Street in which sleazy, market-manipulating Gordon Gecko seeks to make "easy money" not by hard work or innovation but basically by cheating/gaming the financial system. Hmm--sound familiar? Examples abound in all cultures. Look no further than the Chinese stock market mania currently playing out in the Shanghai Composite. For a chart of that madness, go to Mish's recent post (recommended by U. Doran).

One consequence of the "greed is good" mentality which has infected the entire globe is that we are essentially eating our seed corn by feasting today. In the U.S., one way common manifestation of this is the extraction of most or all of the equity (savings/wealth) from one's house via home equity lines of credit (HELOC) or mortgage equity withdrawals (MEW) to spend or "invest" (speculate).

"You're right on with the MEW (mortgage equity withdrawal). My realtor friend who lives on the water in (San Diego), has gone through tax records and found lots of MEW among her neighbors. Some of her neighbors almost paid cash for their homes 10-20 years ago, and then took out $1 mil loans! One of the people with a $1 mil MEW drives a $150K sports car. I suspect they used that money for investing...why would someone who was frugal their whole life all of a sudden go on a spending spree though? Maybe some of the money went for investment property?

The richer they are, the bigger the MEW. $1 mil MEW is not uncommon. About 10% of the people bought 20 years ago or more, and took out no MEW. They are the minority.

Just think of all that money swimming out in the economy.

This is very key: the areas with the highest home appreciation, is where we had the highest MEW. So the entire country's MEW was concentrated in CA, AZ, FL, and the east coast. The Midwest got passed by. They used those exotic loans to purchase homes, but no to do cash outs. They didn't have the appreciation. But they got neg-am loans to refinance into lower payments."

Back to Ugetsu. I won't ruin the film for you--well worth renting, and yes, it's subtitled, but you'll soon forget that--but the heart of the story is two brothers' desire to get rich in a time of civil strife by leaving their poor but loving families. The fundamental illusion--that wealth will bring happiness--is illustrated with a supernatural story element which will take you by surprise.

Alas, the brothers discover the hard way that greed brings not happiness but destruction of all that was good in their lives, all that mattered, all that was valuable, all that was genuine. When will we re-discover this as a culture/people/species?

We all know why Greed Is Currently Good: because consumer and speculative greed is immensely profitable.

Tuesday, May 22, 2007

This Week's Theme: Why The Truth Can't Be Told

The Future Shortage of Energy

Longtime contributor Riley T. checked in recently with a cogent summary of Peak Oil and its consquences:

"I would like to start with my observations about how humans process information. When something enters the mind the first thing we do is compare it to similar things from our past, then we compare the new thing to the similar things and look for differences. We compare and discriminate to process new information. If we treated all new information as unique we would over load and brain freeze ( technical term ). This works most of the time.

I don't have anything to support what I am going to say next other then a life time of reading, observing, too much education and 30 years in accounting and finance.

Here it is: Things are different now. What an over-used phrase.

Humans will not accept bad news.Their time horizon is 1-3 years max.The price of oil has gone from $10-13 to $50-75 a barrel in 8-10 years.We clearly are past peak oil or so close it doesn't matter.If we are past peak this means NO MORE GROWTH.THE ALTERNATIVE ENERGY SOURCES DON'T COME CLOSE TO REPLACING OIL.

The bad news in the U.S. has been covered up by the expansion of credit. Never in the history of the world has there been such a huge expansion of credit, the worldwide asset bubble has never been bigger.

"Swiss experts expect first shortfalls in electric power supply to occur within the next five years. And the energy department in Bern is already busy working on a so-called cut-off plan. Electricity suppliers are already counting on periodic power cuts to entire towns and industrial zones within the next years. Today we cannot begin to imagine twelve hour power cuts in entire cities like Zurich or Frankfurt. "

Monday, May 21, 2007

This Week's Theme: Why The Truth Can't Be Told Why China Is Being Scapegoated We're tackling a big topic today with lots of charts: Why Congress is scapegoating China.

Here's the issue in a nutshell. We all know the U.S. runs a big trade deficit with China, a deficit which is growing. (As this chart shows, we also maintain a deficit with Japan, Germany, the EU and virtually every other trading nation.)

The problem, our astonishingly stubborn elected officials believe, is that China's currency, the renminbi or yuan, is undervalued. China pegs the yuan to the dollar; a few years ago it was 8.25 to the dollar, and now it's under 8.

Congress apparently believes those who say the yuan is undervalued by 40%--meaning it should be about 5 to the dollar. If this came to pass, then Black and Decker would instantly move their factories from China back to the U.S. as it no longer made financial sense to have factories in China.

This is so wrong-headed it boggles the mind. First, Black and Decker et. al. have factories in Asia because that's their fastest growing market. It makes sense to make stuff there--and many of the components are made there, too. Second, wages in China could rise 40% (via the currency devaluation Congress so keenly desires) and that would mean the factory wage of $200 per month would rise to $280--compared to an average U.S. wage of $3,000 (don't forget the mandated benefits and healthcare).

Did anyone notice that unemployment in the U.S. is at multi-decade lows of 4.5%? Is "saving jobs in America" really our most pressing issue? And how does devaluing the yuan actually "solve" that problem? All it does is make Chinese products 40% more expensive to U.S. consumers.

If you're making widgets in China, are you moving the factory back the America now? No, you're squeezing your Chinese suppliers to find 30% cuts in production costs, or moving the factory to Vietnam, where the average wage is $150/month. As this chart reveals, U.S. corporate profits have been on an absolute tear during the rise of the trade deficit with China, skyrocketing to the unprecedented height of $1.3 trillion--fully 10% of total U.S. GDP.

Gosh, do you think there's a connection? Of course there is. You know that $200 iPod that's made in China? Well, about $20 stays in China, because the factories assembling the iPod are owned by Apple, and many of the components are made in factories owned and operated by Taiwanese, Korean and Japanese corporations. China owns very little of the supply chain for the iPod. Manufacturing in hyper-competitive China is a low-profit venture; as I have posted here before. BusinessWeek stated that average profit margin for manufacturers in China is 1%-4%.

Did Steve Jobs become a corporate god by generating profit margins of 2%? No. The real meat of the money--the $180 of the retail price--goes to Apple (huge profit margins), the wholesalers /distributors, and the retailers--all in the U.S. But does Congress even "follow the money" in the real world? Clearly, no.

With a gracious thank-you to Mish, here is a link to Stephen Roach, Economist for Morgan Stanley, stating that Congress is in no mood to listen to reality; across both parties, politicos have already decided the solution to America's ills: Past the Point of No Return. Correspondent James C. recently contributed this observation to the Readers Journal:

I have some strange measures of the American consumerism patterns. I count self storage buildings in the areas that I travel and also monitor how many bags of trash people take out on trash day. (I have never claimed to be normal) There is some virtue to this kind of study. One has to purchase, and then throw away, a lot of stuff to have 5-6 bags of trash at the curb each week. Our household consists of my wife and myself. We usually have one bag of trash each week. Across the street is a household consisting of a husband and wife and they generally have at least 5 bags of trash. Are they 5 times as happy as Barbara and I?

I call Fred, the neighbor above, the "Tool man". He has every conceivable gadget that the Chinese can make. His yard is a little bigger than ours. I mow with a 20" push mower. Fred had three riders, a push mower, a gas leaf blower, a gas trimmer, a gas sidewalk edger, and a gas snow blower! Our society just can't go on like this. Yet when I try to talk to clients about this kind of stuff, they glaze over or say something like, 'that is depressing, I don't want to talk about it anymore." I think this kind of attitude seals our doom!

As this chart reveals, Americans are saving not just zero, but actively spending money they don't have--a negative savings rate. The only other instance where Americans drew cash from savings was during the Great Depression. But we're living in a time of "prosperity," remember?

So where is all this wealth that consumers are spending so freely coming from? From the extraordinary rise of real estate values in the U.S. As this chart shows, real estate assets as a percentage of U.S. GDP has reached unprecedented heights. (That's a phrase which gets repeated here often.) To view charts showing unprecedented consumer debt accrual via re-financing ( a.k.a. "the housing ATM"), please scroll down to the entry of May 11.

Lest you think U.S. consumers are profligate wastrels while Congress is a gleaming tower of fiscal virtue, consider this chart. Yes, that's bankruptcy looming on a national scale-- mandated expenditures (entitlements like Social Security and Medicare, and debt on the national interest) will soon balloon so far above tax receipts that even the profligate borrowers in Congress and the White House will be unable to borrow enough money from the rest of the world to fund the gap.

But like the distracted yuppie parent who can't bear to rein in their bratty, irresponsible child's excesses, Congress dares not tell the American public that they need to spend less and save more. But Why? Here's the answer: the bankers would stop making money.

Here's how it works: find people are who are poor credit risks, then offer them some credit--at an outrageous price and profit margin. What choice do they have? Basically none.

Federal Reserve data show that in relative terms, that debt is getting more expensive. In 1989 households earning $30,000 or less a year paid an average annual interest rate on auto loans that was 16.8% higher than what households earning more than $90,000 a year paid. By 2004 the discrepancy had soared to 56.1%. Roughly the same thing happened with mortgage loans: a leap from a 6.4% gap to one of 25.5%. "It's not only that the poor are paying more; the poor are paying a lot more," says Sheila C. Bair, chairman of the Federal Deposit Insurance Corp.

HAPPY AS SHE WAS with the Saturn she bought in December, 2005, Roxanne Tsosie soon ran into trouble paying off the loan on it. The car had 103,000 miles on the odometer. She agreed to a purchase price of $7,922, borrowing the full amount at a sky-high 24.9%. Mainstream financial institutions are helping to fuel this explosion in subprime lending to the working poor.

Wells Fargo & Co. and U.S. Bancorp now offer their own versions of payday loans, charging $2 for every $20 borrowed. Based on a 30-day repayment period, that's an annual interest rate of 120%. (Wells Fargo says the loans are designed for emergencies, not long-term financial needs.)

Terms of the Tribute MasterCard are a world away from the money-back and frequent-flier offers familiar to more prosperous cardholders. Marketed by Atlanta-based CompuCredit, a giant in the subprime card business, Tribute MasterCard offers no such fringe benefits. Rose Ajuria's card carries an interest rate of 28%, compared with about 10% on a typical card.

McBride graduated in 1992, owing $45,000 on student loans. That debt became her main financial burden, she says. The 9.5% interest rate isn't particularly steep, but she tended to view the payments as less pressing than putting food on the table or paying rent. Late fees piled up. Today she owes $159,991, up from $117,000 only 18 months ago. When dunning notices arrive, she tosses them in the stove. Personal bankruptcy proceedings in 2003 dissolved dozens of McBride's liabilities. But by law her debt to student lender SLM Corp. (SLM ), better known as Sallie Mae, wasn't affected. Every month, $450 is garnisheed from her wages, reducing her take-home pay to $1,338. The garnishment doesn't even cover interest and penalties, let alone the principal. Says McBride: "There's no way this thing will ever be paid off."

Did I mention that "you owe us forever" Sally Mae was recently bought by a private equity firm? I wonder why--could it be the debt which even bankrupcty can't trim? And who muscled that bankruptcy law through a complacent Republican-ruled Congress a few years ago? Your friendly U.S. bankers. If you foolishly believe the bankers have no political influence, I advise you to study the bankruptcy laws. Contributor/blogger/attorney Fred Roper can help set you straight on just how pernicious and anti-consumer rights this "bankers law" truly is.

And if your naivete needs more bashing, please read this from the S.F. Chronicle Bankers oppose fee, rate limits. The chart above shows how banks have become extraordinarily dependent on mortgages for their profits (total earning assets).

This chart depicts how housing has become the linchpin for the American homeowner: the value of housing as a percentage of disposable income has skyrocketed to--you guessed it--unprecedented heights.

So let's add all this up. Bankers are making vast, unprecedented fortunes selling debt to Americans--mortgages and home equity lines of credit to homeowners, mortgage-backed securities to investors/speculators, and sky-high consumer debt to subprime/low-income consumers.

Meanwhile, back at the ranch, American corporations have exploited cheap manufacturing in China to reap record levels of profits--fully 10% of the entire U.S. GDP is corporate profit. The essential ingredient in all this stupdendous profiteering is, of course, the American consumer's debt and spending binging.

And that's Why The Truth Can't Be Told. If Americans were told that their profligate spending is the problem, and saving more is the answer, then guess what? Fewer loans and debt equals contracting profits for banks, and more savings means contracting sales and profits for U.S. retailers, manufacturers and the entire supply chain. In other words, the profit party stops. So let's blame China instead.

Saturday, May 19, 2007

Is This 1972 Redux--or 2000? Or Some of Both?

First up: some logistics. The Readers Journal has finally been updated, and there's a wide variety of smart thinking on elites, taxes and dirt (seriously). Without healthy, living dirt, we'd all starve. And recovering soil that's been paved over is very difficult.

Click on the links to your right for commentary you won't get on namby-pamby mainstream media sites or ideologically "pure" sites that "preach to the choir." Here every thoughtful opinion is welcome--Libertarian, Republican, Democratic, Anarchist, Buddhist, Taoist, Animist, you name it. (I praised Nixon here a few days ago, and you can't get more un-PC than that.)

Reader Aaron O. quite rightly asked why I don't have an RSS feed for each full entry, and I need to mention that I've set up a "mirror site" on Blogspot which you can read in its entirety with Google Reader or equivalent. My apologies for not mentioning it sooner. I still hand-code an RSS and Atom summary, but if you prefer to see the whole enchilada, then switch to the Blogspot page, which I update daily. (Some charts are missing, as the formatting is funky. But you can easily click over here to see the charts.)

While I'm writing you emails, I thought I'd bounce something off of you concerning your thoughts that we're careening toward a depression in the next decade ... Looking around I can't help but agree that these "good times" can't last forever. I'm dumbfounded how housing prices can double in a few years and everyone just accepts it as normal market forces. I keep waiting for tougher times to set in, yet somehow they have lasted without a serious recession since the 1970's. So, I'm in agreement with your writings that things aren't what they seem, and it won't last. I mean, the parallels to the 1920s is startling! However, this little voice in the back of my mind wonders if things won't turn out like anyone expects.

Here's my thought: You and I aren't the only ones thinking things will take a turn for the worst in 2011. Harry Dent thinks so (famous Bull from 1990s) based on his demographics research. So does Robert Kiyosaki (best selling author of Rich Dad/Poor Dad) with his Prophecy book based on the ERISA act. So, this gets me thinking ... if so many well-known folks are anticipating tough times ahead, then will it actually happen? Could something so obvious from a historical perspective actually occur?

Your thoughts would be appreciated.

I'm going to start my response with a chart:

As we now know, Greenspan's warning was valid. But it took three years for the market madness to reach its final zenith. Every year that the tech euphoria continued, the chorus of doubters/naysayers grew larger. Warren Buffet famously avoided the tech sector, and ended up apologizing to his shareholders in 1999 for not matching the returns reaped by momentum players in that mad year.

But the doubters were right--it just took time for a market disconnected from reality to revert to the mean, or cycle back to fundamentals. As for the current fundamentals--please scroll down to the entry of May 11, 2007 for a chilling snapshot of an economy of consumers (70% of the U.S. GDP is consuemr spending) which has been dependent on debt to fuel "prosperity." The consumer's ability to acquire and support ever more debt is clearly nearing the end of a debt-bubble cycle.

The only possible outcome is reduction in borrowing/lending, reduction in spending, reduction in GDP and reduction in corporate profits which necessarily means a contraction in price-to-earnings ratios--a fancy way of saying the stock market has to tank as earnings wither.

So it seems anticipating a financial return to reality (i.e. a downturn brought on by reduction of lending/borrowing) does not preclude that downturn from happening--though it is always wise to ask: what else might happen? I think the charts posted on May 11 provide little support for any other future but contraction/recession.

In one way (real world) it really seems to be 1972, a losing war, a surge (i.e. Rolling Thunder bombing campaigns), a president under seige, a government no one trusts, inflation running rampant but no one believes it, lots and lots of industries about to go bottom up. (1972, steel, autos, 2007, IT, computers, autos (well ok, that one is the same :-) ). People living the easy life (1960’s vs. 1990’s) and no real threats to their real living about to get ALL SHOOK UP. Most of the 70s were a tough time for a lot of people and they learned to do without and learned some new skills, could it happen again, or are those skills (surviving without total government nannyism) gone forever now?

But then, there’s the stock market. Maybe it’s 1972 and the Nifty Fifty again, but I wasn’t paying attention to the stock market then but I was in the late 90’s and I was very conservative (still am, especially for a young ‘un) and yet everyone and their mothers were buying stock in 1999, 2000 and going wow, this is great, first time I’ve ever bought stock and it just goes up. The stock market goes up and up and never a down day. (It kills me that I’m in cash, but the day is coming). And the other day a friend of my wife who’s never bought stock or followed the stock market or anything (mid 40’s) tells my wife that she’s now in the stock market and having fun. If that’s not an indication of the year 2000, I don’t know what is.

I have another unrelated thought you might get a kick out of, although I guess it does relate a lot to my 1972 analogy again. In the 1970’s, a lot of the "big" companies of today were born and/or forged by people dealing with the hard times/ no jobs or had lost their jobs from their “lifetime” employers. (i.e. Apple Computer, most of the IT stuff--actually pretty much all, as the old companies reinvented themselves, or are gone). Perhaps the same is coming due again.

The only "good" jobs are those government jobs with no work and high pay and zero risk (but I’m not bitter :-) ) Most of the big companies are TOTALLY stagnant, stuck in a morass of rules and HR crap and diversity campaigns. Nothing new is rarely invented by big companies although many times it’s improved and sold. Maybe we need a big shake up (1970s?) to get people working again at things that matter and using their skills and getting rid of all the crap. Maybe, maybe it’s impossible because of all the rules (of which there are tons every year, you just have to decide as a small business which ones to ignore to be successful).Interesting parallels. My only suggestion would be to say the stock market is like 1973, at a peak within the secular Bear market which started in 1966 (or in our era, 2000). As noted here in previous entries, this 7-year peak also occured in 1929-1936, as well as 1966-1973. Therefore history suggests the current "new market high" will be the last one for some time to come.

I would also note that the 1972 "Christmas bombing" of Hanoi and the mining of Haiphong Harbor finally led the North Vietnamese to the bargaining table. Why? The U.S. had long been wary of triggering Chinese or Soviet involvement in the Vietnam War (even though Russians were piloting supposedly North Vietnamese MIG fighters) and as a result avoided hitting Hanoi or Haiphong Harbor, where a decoy Soviet freighter was always tied up to discourage any such attack.

After four years of losses and political intransigence, Nixon and Kissinger finally tired of this "limited war" gamesmanship, and they made the calculation that neither China nor the U.S.S.R. would open a wider war if they went for the North Vietnamese jugular.

The North Vietnamese had Soviet SAM-3 anti-air missiles, which knocked down many U.S. B-52s. But the war of attrition was won by the U.S., for with the harbor mined and the re-supply of SAMs cut off, the North Vietnamese soon expended their missiles. At that point they were in danger of losing their capital, their dikes, and whatever infrastructure was being enjoyed by the political elite. Within a matter of days, they basically sued for peace.

As a further footnote, the surrender of South Vietnam two years later in 1975 might not have been as preordained as is widely perceived. For the U.S. Congress had cut off funding to the South Vietnamese, a move President Ford could not stop. Without the financial means to fund a military response to the armor (tanks) of the well-supplied North Vietnamese army, then the cut-off of funding was equivalent to surrendering South Vietnam.

Was it good policy to cut off funding? Was it "worth it" to fight the war, or end it by ending financial support of South Vietnam? History can't be replayed; maybe the corrupt South Vietnamese regime was doomed, regardless of U.S. airpower or re-supply of weaponry. That is open to debate--a debate made sharper by the current political battle over ending funding of the war in Iraq.

Friday, May 18, 2007

The Moon's a Balloon--And About to Pop

The seemingly inexorable rise in the U.S. stock indices is one of Nature's most perplexing mysteries. How does the economy weaken? Let me count the ways... housing is tanking, consumer spending is tanking, even the manipulated/phony consumer price index is rising at nearly 5% a year, gasoline is getting more expensive by the day, job "growth" is utterly bogus--but so what, the market keeps rising anyway.

Ever wonder why? Well, here's your answer: so insiders can dump all their shares at the top to unsuspecting buyers who unwittingly believed the phony hype about how leveraged buyouts and the magic elixir of liquidity would support higher stock prices for the foreseeable future. Oh, and the Fed will be lowering interest rates real soon, too . . .

For a view of reality as opposed to fantasy, look at the number of shares being bought by insiders (if you're an insider, and you know the stock will be rising, you buy before the public catches on) and insider sales (insiders are selling because why? They know the price will be skyrocketing soon? Hahahahaha.)

My good buddy "Huevos" over at "Changos Teahouse of the Almighty" provided this summary of insider buying and selling. This metric is closely watched, because it is obvious that insiders know the prospects of their company and industry better than mere "investors"; thus if they're selling, it does not bode well for future stock market gains. In Wall Street lingo, this is called "distribution." When insiders are buying, it's called "accumulation." This is clearly distribution, on a stupendous scale.

This data makes you ask: if things are so great, why are insiders selling vast quantities of their shares and buying virtually nothing? Even in good times, insiders sell more than they buy, as stock options and grants give them "free shares" to sell. But the ratio of sells to buys is 1-to-1 or 2-to-1 in good times, not 100-to-1 or 200-to-1.

Thursday, May 17, 2007

A Short Meditation on VineyardsThis California vineyard might well be in France, Chile, or Australia. Humans have cultivated grapes and made wine for thousands of years, and regardless of what other industries rise and fall, we can safely presume we will continue to nurture vineyards hundreds and even thousands of years into the future.

My brother and his wife live in a small village in the Cevennes region of the south of France. As you might imagine, there are vineyards within a stone's throw of their house. On my last visit, I walked a number of kilometers down one of the many country lanes, through a small valley of vineyards and other crops. Other than the sound of motor vehicles and the paved road, the scene was probably much like it was 100 or 200 years ago.

In the village, a large old building lies vacant. My brother tells me it once contained a silk factory. I knew from reading Braudel's "Civilization and Capitalism, 15th to 18th Centuries" (the three volumes listed in yesterday's entry) that France once had a thriving silk industry centered in Lyon. Tremendous wealth was generated by that industry hundreds of years ago, a boom which lasted many decades. Now virtually nothing is left of it.

Might the ugly concrete tiltup buildings of Silicon Valley be torn down one day, and replaced with "higher value" orchards similar to the ones ripped out in the 1960s to make way for the tech boom? It seems improbable from our narrow decades-long view; but from the view of "civilization and capitalism" stretching out hundreds of years, then the rise and decline of entire industries and entire trading empires is the norm.

I am not necessarily suggesting a "decline of civilization" or "return to agrarian poverty" in proposing such a scenario; what Braudel documents so entertainingly is how capital flows to the easiest and most profitable businesses. Thus when trade routes to India bypassed Venice and its Arab trading partners, the Venician capitalists bought land on the mainland and became wealthy agriculturalists.

Thus there could be a time when the work performed in Silicon Valley has moved elsewhere, and the owners of capital realize that the value of the rich land under the concrete in a hungry world far exceeds the value of the cubicles in the buildings. Then capital will tear down Silicon Valley and plant "higher value" orchards. Silicon Valley will the be seen as a brief interruption of a much longer and more enduring agriculturally based wealth-creation.

Two other issues lay just over the horizon of this bucolic image. One is that vineyards are labor-intensive. The tender care and harvesting will probably never be performed by machine, for the simple reason it will always be cheaper to hire homo sapien sapiens v1.0 than it will be to manufacture, maintain and deploy machines complex enough to trim the tendrils and snip off the bunches of grapes without damaging the plants or harvest.

The other issue which is revealed by what is not visible in this photo is land use. In unbridled capitalism, these vineyards would be gone, replaced by gaudy palatial McMansions and "mini-ranches" with a little vineyard in front for show, so the wealthy social-climbing wannabes could have their quarter-acre of grapes to show off to their phony friends.

Why would this happen? No matter how great the vintage, no mere vineyard can compete with $5 million cash for a relatively small plot of land. Some decry the imposition of land use on "free flow of capital." This particular corner of California is very tightly restricted by local government; you cannot plant new vineyards on slopes so steep that the erosion could damage the terrain, nor can you drill a well wherever you like and extract the precious groundwater. As a result of these "onerous" restrictions, the vineyards remain.

One result of these restrictions, of course, is the value of existing homes has been driven ever upward by limited supply. But even if most of the vineyards were paved over and a 1,000 new stucco box mansions were built, the price would still be high--for in a world awash with wealth and borrowing power, a mere 1,000 mansions is nothing. The demand for "luxury property" is essentially insatiable--at least until the Great Depression of 2011 comes round.

We cannot know what industry will rise or decline in the next 100 years; we can only know that industries will rise and others will decline to dust. But through it all, patient hands will be tending grape vines, and worrying about frosts, and testing acidity and sugar to decide if today is the day to harvest. Here is a clue to this particular location: RDS.

Those are the initials of the local vineyard owners' group. It's obscure, but the valley itself is too well-known and too famous to be worthy of a "where is this?" If you can identify the terroir, and you'd like a signed copy of my little novel about the American road and identity, I-State Lines, I'll gladly send one to the first correct guess. There is a tiny clue buried in the paragraph above.

Wednesday, May 16, 2007

Books: Readers' Recommendations I learn a tremendous amount from you, the readers of this humble site--from your experiences, your insights, your reasoning, and from your recommended reading. To share this wealth of ideas and sources, here is a selection of books which readers have recommended to me recently. I am a slow reader and therefore still working through the list. I have never been disappointed in a reader's suggestion.

As a reminder: I post links to Amazon.com so you can access other readers' reviews of each title. If you buy a book through Amazon, I receive a sliver of a commission at no cost to you--Amazon simply shares a bit of their proceeds with me. You can often borrow these for free at a library, or find a copy used online or in a used bookstore. And I also consistently recommend buying some books at your independent bookstore, if there is one in your area.

First up: frequent contributor U. Doran recently recommended a number of modern finance / economics classics, and one which may well join that select list:

For anyone wishing to improve their understanding of the stock market and their trading, frequent contributor Harun I. recommended: Reminiscences of a Stock Operator

Anyone seeking to understand how global capital is deployed as a means of political and financial control would benefit from this title recommended to me by my sister: Confessions of an Economic Hit Man

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